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Speculation Lower - Production to New Highs - Inventory Lower - Prices Up
During the week ending December 22nd, the spot month diesel futures price increased by 6.59 cents per gallon (+3.46%) while the deferred months increased by 4-7 cents per gallon making the forward pricing curve higher and more negative in slope. The one year forward price ended the week at a 5.76 cent discount to the spot price, from a premium of 4.46 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates higher demand expectations and lower inventories with respect to demand. Demand also includes speculation which was lower on the week. When the forward pricing curve decreases in slope (more negative or less positive), this usually indicates tighter inventories and is generally positive for price. When slope increases, this usually indicates more plentiful inventories and is negative for price.
During the week ending December 22nd, the spot month gasoline futures price increased by 10.75 cents per gallon (+6.50%) while the deferred months increased by 4 to 6 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at an 8.44 cent discount to the spot price, from a discount of 3.79 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates higher demand expectations and lower inventory levels with respect to supply and demand. Demand also includes speculation which was lower on the week.
The US dollar was lower on the week which is positive for price. Inventories on the week were lower which is positive for price. The stock market, as a proxy for demand expectations, was higher which is positive for price. Speculation was lower on the week which is negative for price. US domestic crude production was higher which is negative for price. Domestic production is up 11.42% on a year over year basis. Oil rig count, indicating the number of oil wells currently being developed, was unchanged on the week which is neutral for price.
Weekly US petroleum demand increased by 3.13% during the week ending December 15th. Domestic demand is up by 2.59% vs. one-year ago and demand is currently 1.09% below the five year average.
Domestic production increased on the week and is 11.42% above year ago levels. The number of operating oil drilling rigs in the US was unchanged at 747 which is 21 lower than the recent high of 768. Currently, this is 431 more than the recent low of 316 in 2016 and 53.57% lower than the peak of 1609 in October 2014. The relatively high rig count is causing US production to grow as the global rebalancing of supply and demand and the return of global inventories to normal levels continues. US domestic production has increased by 1,361,000 barrels per day (+16.15%) since the recent low on July 1, 2016 and has increased past the old high from June 2015 of 9.61 million barrels per day.
Below is the one-year chart of spot diesel futures prices as of December 22nd.
Below is the one-year chart of spot gasoline futures prices as of December 22nd.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories decreased on the week and were down by 4.49 million barrels while inventories were expected to decrease by 1.90 million barrels on the week. The five-year average inventory increased by 1.04 million barrels. Inventories decreased vs. the five year average and increased vs. expectations.
: : The North Sea pipeline that was halted due to a hairline crack on December 11th is scheduled to resume operation in early January. This will restore this supply to the North Sea and should be negative for price when supply resumes.
: : The Stock market increased by +0.28% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreased by -0.62% on the week is positive for petroleum price. Commodities are used as a hedge against inflation and against a falling dollar. A stronger dollar reduces the relative demand for commodities for this purpose and prices decrease accordingly. Conversely, a weaker dollar increases relative demand for commodities and prices increase.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of December 2017. According to the chart, global supply and demand have essentially rebalanced during the first three quarters of 2017 with a slight deficit and are expected to remain roughly in balance through 2018 with a slight deficit. This expectation of balance of supply and demand will be supportive of price.
Below is the one-year chart US stock market prices as of December 22nd.
Below is the one-year chart for the US dollar index as of December 22nd.
During the week ended December 15th, total petroleum inventories decreased by 4.49 million barrels vs. a five year average increase of 1.04 million barrels and vs. an expected decrease of 1.90 million barrels. Inventories decreased by 5.52 million barrels vs. the five year average and decreased by 2.59 million barrels vs. expectations. Total inventories stand at 793.1 million barrels, down from 797.6 million barrels at the end of the previous week. The five year average inventory is 750.8 million barrels, up from 749.8 million barrels at the end of the previous week.
Current inventories are 5.63% higher than the five year average, down from +6.38% at the end of the previous week.
As of December 19th, the net speculative long position in petroleum futures was 521,219,000 barrels, down 7,397,000 barrels (-1.40%) from the previous week. Speculation decreased for the third week and represents 65.72% of domestic inventories. Speculation is 52.28% above its one year moving average. The corresponding spot month diesel futures price on December 15th was 193.99 cents per gallon, up 0.63 cents from 193.36 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 76.55% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 58.60% of diesel fuel price movements are explained by changes in level of speculation.
The net speculative long position has been variable over the past year ranging between 81 million and 562 million barrels with an average of about 342 million barrels, which is up roughly 4 million barrels on the week.
Based on a multiple regression analysis considering the level of the dollar, speculation, and inventory over the past five years as of December 19th, the market price for spot month diesel futures is estimated to be 227.72 versus the actual price of 193.99. This indicates that the market is currently undervalued by 33.73 cents per gallon given the assumptions of the pricing model.
Linwood Capital, LLC is an institutional fuel hedging management, advisory, and consulting firm. Linwood creates and manages customized fuel hedging programs for institutional consumers of petroleum and natural gas.
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